Like a Guaranteed Income?

Then a prescribed annuity could be a very tax effective alternative to your GIC interest income.

Non-registered Annuity Income

 With an annuity you trade your cash for an income. The income you receive is made up of an interest portion and a return of your capital portion. It might help understand better if you think of a mortgage payment. Initially the payment is made up of mostly interest and some principle then as the mortgage approaches maturity the payment is mostly principal or return of capital. An annuity is like a mortgage in reverse, you are the one “lending” the money and are receiving an income in return. 

The return capital portion is tax-free and the interest portion is taxed, as you would expect as interest income. You would then expect the amount of income lost to taxation initially to be quite high and reduce over the term of the contract. You are correct EXCEPT if the annuity qualifies as a Prescribed Annuity. The Prescribed Annuity spreads the taxation evenly over lifetime of the contract. To qualify for this preferred tax treatment some of the conditions, which must be met, are:

	only individuals can own the annuity the policyowner and annuitant must be the same person except for spousal and testamentary trusts
	no indexing of income payments is permitted ownership cannot be changed except on death
	guarantee period must expire before the annuitant’s 91st birthday
	if a joint and survivor annuity is issued the survivor annuitant must be the spouse, brother or sister of the primary annuitant
	the annuity cannot be surrendered or commuted except on death

A prescribed annuity can be a very tax effective alternative to GIC interest income.

 To illustrate:

Bob and Mary are both age 65, non- smokers, in good health, and have invested $100,000 each in Guaranteed Investment Certificates (GIC’s) at 4.2 %, which provide them each with about $4,200 in income each year. They both have other pension income, and their marginal tax rates are approximately, 40% per cent, so they will pay $1,680 in taxes each on this GIC income, and will be left with $2,520 each year. They do not need to worry about their capital eroding so it will be intact for their heirs.  

Some Alternatives:

Bob takes his $100,000 and invests in a Prescribed Annuity that will pay him $8,820 for life. The taxable portion will be a level $2,839 so assuming a 40% tax bracket his tax would be $1,136 leaving him with $7,684 of income each year. An additional $5,164 each year. If Bob is concerned about leaving the $100,000 for his heirs then he could purchase life insurance for a level approximately $3,130 a year leaving him still with an after tax income of $7,684 - $3,130 = $4,554. This is $2,034 more income in hand than with GIC’s.

Mary takes $60,000 and invests in a Prescribed Annuity that will pay her $4,713 for life. The taxable portion will be a level $1,624 so assuming a 40% tax bracket her tax would be $650 leaving her with $4,063 of income each year. An additional $1,543 each year. She has $40,000 to invest in equities to protect against inflation and to have access to the capital. If she uses segregated funds the life insurance element would typically provide for a death benefit guarantee of 100% of amount invested less any withdrawals. 

 

Points to Consider 

1.  If they did not have other pension income the annuity would qualify for the pension deduction. 

2.  When interest rates are low (as illustrated) then annuity rates are low.

 3.  The higher your tax bracket the further you are ahead.

 4.  Consider as part of your overall plan.

 

  For more information contact:

 

J. Paul Wilson, CFP, CLU, CH.F.C., TEP

2-33 Thorne Avenue, Dartmouth, Nova Scotia, B3B 2E7

 Halifax/Dartmouth (902) 429-2696 ext. 225   Toll Free 1-877-429-2696 ext.225

Web site: www.jpw.ca  Email: paul@maritimewealth.com

The information contained in this article is intended to provide general guidelines only. The application and impact of the law can vary widely from case to case based on the specific or unique facts involved. Accordingly, the information in this article is not intended to serve as legal, accounting or tax advice. Users are encouraged to consult with their professional advisers for advice concerning specific matters before making a decision.